Four Efficient Steps to Understanding a Small Entity and Its Environment

Dec 10th 2010
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Remember the rule substance over form?  The purpose of auditing standards is to enable an auditor to obtain reasonable assurance financial statements are presented fairly in accordance with the applicable financial reporting framework.  An auditor is required to use professional judgment in applying auditing standards.  Professional judgment is the substance of auditing standards, not a canned set of practice aids.  Professional judgment is demonstrated by the auditor’s ability to think and reason in the unique circumstances of every audit.  

While an auditor may use certain practice aids to plan, perform and complete an audit, these documents only accomplish the substance of auditing standards if they are tailored for each engagement’s circumstances.  Modifying the content of such practice aids, as well as adding or eliminating certain forms, checklists and other documentation, enables the auditor to develop cost-beneficial audit strategies.

For small audits, it is possible to comply with the requirements of SAS No. 109, Understanding the Entity and its Environment, by applying and documenting professional judgment in these four steps:

1.    Use general organizational, operational and governance information from Client Acceptance and Continuance Form to obtain a basic understanding of the client’s business and industry.
2.    Read and analyze the detailed general ledger for support tests, unusual transactions, general journal entries, errors, etc. and document results.
3.    Prepare internal control flowcharts and documentation of systems walk-through procedures.
4.    Prepare a document summarizing all engagement planning activities and decisions.

There it is: substance over form!  We eliminate lengthy, unnecessary practice aids and use professional judgment to comply with the substance of the auditing standards.  There is no reason to do more!

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